Bulletin – September 2018
Financial Markets
Money in the Australian Economy

Abstract

Money forms part of our everyday lives and is integral to the smooth functioning of the
financial system and the real economy; however, discussions of what money is and how it
is created are generally left to economics textbooks. This article provides an
introduction to the concept of money and describes how it is created and measured. We
also discuss what these measures can tell us about economic activity.

What Is Money?

Characteristics of money

In the most general sense, money refers to something that is widely accepted as means of payment
– commonly referred to as a medium of exchange in economics textbooks. What is
‘widely accepted’ depends on the context. For example, Japanese yen are widely
accepted as a means of payment for goods or services purchased in Japan, but not in Australia.
Similarly, whereas rum was widely accepted as a means of payment in the early days of Australian
colonisation, the same cannot be said of today. This contextual element highlights that whether
something is considered to be money or not is at least partly the result of convention –
that is, a situation has arisen where people believe that this something called money will be
accepted as a means of payment and, as such, they believe there will be continuing value in
holding this form of money in order to make future payments.

This belief that there will be continuing value in holding money as a method of making future
payments touches on a second property of money: it tends to be a good store of value.
If you are going to hold money primarily for the purpose of purchasing other goods or services,
it is important that it holds its value over time. If a type of money was not a good store of
value, you would want to spend it quickly because its purchasing power would decrease over time.[1]

In addition to the two properties above, a third common property of money is that it is used as
a unit of account. For example, it is common for prices to be expressed in terms of the
number of units of the money that is widely accepted as a means of payment. For example, the
price of a cup of coffee is expressed as the number of Australian dollars required. If it were
expressed in terms of some other unit of account (e.g. a foreign currency) then the current
exchange rate between Australian dollars and that other unit of account (e.g. US dollars) would
need to be known to all parties participating in the transaction.

All goods exhibit ‘money-like’ qualities to varying degrees.[2] Non-perishable
goods typically serve as a store of value for some period; most goods can be used as a medium of
exchange, albeit with varying difficulties; and any good can be used as a unit of account,
although the calculus required to value one good in terms of another is often inconvenient.
Institutional settings – such as the currency recognised by the government as a means of
paying taxes (and receiving benefits) – often play an important role in determining what
becomes accepted as money in an economy. While there is typically nothing stopping the use of
other currencies for private transactions, in most modern economies, convenience and convention
have resulted in just one type of money becoming the medium of exchange and unit of account.[3],[4] In Australia, that type of
money is Australian dollars, although this money can take a number of forms.

Types of money

The two forms of money most commonly used to make payments in modern day Australia are currency
– Australian banknotes and coins – and Australian dollar deposits.[5] Both can be used
readily as means of payment for goods and services in Australia, the prices of which are
typically expressed in Australian dollars. The Reserve Bank has a role in ensuring that
Australian dollar currency and deposits are a good store of value: by achieving a low and stable
rate of inflation, the Reserve Bank helps to maintain stability in the purchasing power of
Australian dollars (both in terms of currency and deposits). Also, prudential regulation and
supervision helps to ensure that deposits are a good store of value by ensuring that authorised
deposit-taking institutions (ADIs) are able to meet the demands of their depositors in full.[6]

When the colony of New South Wales was established in 1788, colonists relied on barter and
used rum (spirits) as a makeshift currency. In 1792, a shipment of Spanish dollars was sent
to Australia for use as currency alongside the other international currencies that were used
in the colony at the time. To address persistent coin shortages, new forms of money were
developed in the following decades. These included the creation of the holey dollar and dump
by Governor Macquarie (which made two coins out of one), the use of promissory notes or
IOUs, and copper tokens issued by businesses. IOUs and copper tokens proved an unreliable
source of currency, partly because they had no official guarantee.

In 1825, the British Government legislated a sterling currency for the colony, which
remained the basis of Australian currency until the transition to decimal currency, the
Australian dollar, in 1966. Australia's first gold coins were minted in 1855. The gold
rushes spurred the development of banking and commercial banks issued banknotes backed by
gold, though these banknotes did not constitute a national currency. Like many other
countries at the time, Australia adhered to the gold standard and the total amount of notes
that banks could issue was limited by their gold reserves. At the turn of the twentieth
century, Australia's currency remained a mixture of British coins, Australian coins and
the notes of private banks and the Queensland Government.

In 1910, legislation for a national currency was enacted. The Australian Government issued
‘superscribed’ banknotes, whereby words were overprinted on notes purchased from
the private banks. These were the first currency notes accepted across the nation. The first
true Australian banknote was produced in May 1913, with additional denominations produced
during 1913 to 1915.

How Is Money Created?

Australia's notes and coins are produced by the Reserve Bank of Australia and the Royal
Australian Mint, respectively. Australian banknotes, which represent around 95 per cent of
Australian currency by value, are a liability of the Reserve Bank. Under established agreements,
commercial banks purchase banknotes from the Reserve Bank as required to meet demand from their
customers. Hence, growth in the value of banknotes in circulation represents growth in the
demand for cash.[8]

Australian deposits are liabilities of Australian financial intermediaries such as ADIs.[9] Deposits are
created when funds are credited to a deposit account at an Australian financial intermediary.
For example, when a business takes the cash revenue it has earned to a bank at the end of the
day it exchanges currency for an increase in its deposit balance. This type of transaction
creates a deposit, but does not create money, as the business is simply exchanging one type of
money (cash) for another (a deposit).[10]

More importantly from the perspective of money ‘creation’, deposits can also be
created when financial intermediaries make loans.[11]
When a bank extends a loan, it makes a sum of money available to the borrower (for example, to
buy a car, a house or equipment for a business). Typically, this will be in the form of a
deposit. The bank may credit the deposit account of the borrower, who withdraws the funds when
making their payments. Alternatively, the bank may credit the deposit account of the seller of
the asset, good or service that the borrower was intending to buy (on behalf of the borrower).
In either case, the deposit will typically end up being in the account of a seller of an asset,
good or service.

The process of extending loans will therefore typically create deposits at a system-wide level,
although it may or may not create deposits at the intermediary that extended the loan (see
‘Box B: Money Creation Case Study’ for more details). In the
same way that extending loans will typically create deposits, repayment of loans will typically
extinguish deposits. For example, if the deposit funds credited to the seller are used to repay
an existing loan, the (system-wide) deposit base will remain as it was before this series of
transactions. Other transactions of financial intermediaries can also create or extinguish
deposits and therefore money (see ‘Money, deposits and bank funding’ section).

While the process of extending loans is integral to the process of money creation, this does not
mean that financial intermediaries are able to make loans and create money without limits.
Deposit-taking institutions need to hold sufficient liquid assets to meet withdrawals from
depositors (to ensure that repayment obligations can be met without selling illiquid assets);
assets (loans) needs to be backed by capital (to absorb any losses arising from defaults or
other sources); and the rate of return on assets must be sufficient to cover the costs of
deposits and other funding sources, and operating costs, while allowing the financial
intermediary to earn a profit so that shareholders will earn a return. These all serve to
constrain the extent of lending of any financial intermediary seeking to remain in business.
These limits are further reinforced for ADIs by minimum liquidity and capital adequacy
requirements set by the prudential regulator (refer to ‘Box B: Money
Creation Case Study’ for further examples).

Money, deposits and bank funding

As noted above, deposits represent a liability for the financial intermediary, which has an
obligation to repay the depositor in full. These deposits represent a source of funding to
support the financial intermediary's assets (including loans). But deposits are not the only
source of funding available to financial intermediaries – they can also raise funds by
issuing debt or equity securities.

When a bank issues a debt security such as a bond, the holder of that security pays the bank a
sum of money for the debt security. The effect of this payment (assuming it is not paid for
using currency) is to decrease the deposit balance of the security holder by a commensurate
amount while leaving the banking system's total liabilities unchanged; that is, the
reduction in deposit liabilities has been offset by an increase in bonds issued.[12]
Thus the result of this transaction is a decrease in the money stock (via a decrease in
deposits) but no change in the overall stock of banks' funding liabilities.[13]
Conversely, when the bond is redeemed, if the holder has their deposit account credited with the
proceeds, this increases the money stock and the banking system's deposit funding while
leaving the stock of bank funding unchanged.

This example highlights that transactions of financial intermediaries, such as issuing or
redeeming bonds or issuing equity securities, can affect the money stock. Accordingly,
individual banks' decisions about the use of different sources of funding will also have
implications for the aggregate stock of money in the economy.

The share of Australian banks' funding that comes from domestic deposits has risen
significantly since the global financial crisis as banks have become less reliant on funding
sources such as short-term debt (Graph 1).[14]
The decline in the share of short-term debt securities issued by Australian banks and the
increase in domestic deposits implied a larger money stock than would have occurred if the
funding shares had remained unchanged.[15]

Graph 1

Box B Money Creation Case Study

This box sketches out the process of money creation through loans and deposits at financial
intermediaries on a fictional island, illustrating some of the concepts outlined in the main
article.

The first two banks open

Currency – notes and coins – are widely used on our fictional island, but there
has been no banking system – and therefore no deposits. Two commercial banks open
their doors, one with $100 of equity and one with $50 of equity. The initial balance sheets
of both banks are shown below (with cash representing the physical currency asset arising
from the shareholders' equity) (Figure B1).

Figure B1: Initial State

Hypothetical bank balance sheets, dollars

Bank A

Bank B

Assets

Liabilities

Assets

Liabilities

Cash

100

Equity

100

Cash

50

Equity

50

A borrower arrives

Let's first consider the case where a customer (Borrower 1) turns up at Bank A seeking a
loan of $80. If Bank A decides to make the loan, as a first stage they record a loan asset
and credit the customer's deposit account with the funds (Figure B2). The customer then
withdraws $75 to use, decreasing Bank A's cash holdings and deposit liability (Figure
B3). This highlights that, in order to make the loan, Bank A needs to hold sufficient cash
(liquidity) to enable it to pay out the funds when the loan is drawn down. Note that, if the
customer had wanted to borrow $120 and Bank A agreed to lend them this amount, then Bank A
would have had insufficient cash (liquidity) if their customer wanted to withdraw the entire
value of the loan; in addition, as the loan would have exceeded the entire amount of equity
available to the bank, if the borrower were unable to repay the loan then the bank's
equity (capital) would have been wiped out.

Figure B2: Borrower 1 – Funds Available

Hypothetical bank balance sheets, dollars

Bank A

Bank B

Assets

Liabilities

Assets

Liabilities

Cash

100

Deposit

80

Cash

50

Equity

50

Loan

80

Equity

100

Figure B3: Borrower 1 – Funds (Partially) Withdrawn

Hypothetical bank balance sheets, dollars

Bank A

Bank B

Assets

Liabilities

Assets

Liabilities

Cash

25

Deposit

5

Cash

50

Equity

50

Loan

80

Equity

100

Bank A's customer then uses the $75 they have withdrawn to pay a business (Depositor 1),
who deposits that money with Bank B (Figure B4).

Figure B4: Depositor 1

Hypothetical bank balance sheets, dollars

Bank A

Bank B

Assets

Liabilities

Assets

Liabilities

Cash

25

Deposit

5

Cash

125

Deposit

75

Loan

80

Equity

100

Equity

50

A second borrower arrives

Now a new customer (Borrower 2) approaches Bank B wanting to borrow $40. If Bank B decides
to make the loan, and the customer withdraws the entire amount of credited funds, Bank B's
balance sheet will look as follows (Figure B5). Note that if Bank B had lent more than $50
this would have left Bank B in a position where it may have had insufficient liquidity
(cash) to cover its deposits and insufficient capital to survive if the borrower were to
default.

Figure B5: Borrower 2

Hypothetical bank balance sheets, dollars

Bank A

Bank B

Assets

Liabilities

Assets

Liabilities

Cash

25

Deposit

5

Cash

85

Deposit

75

Loan

80

Equity

100

Loan

40

Equity

50

If the $40 withdrawn from Bank B is used to pay a merchant who in turn deposits the funds at
Bank A (Depositor 2), the result is shown in Figure B6.

Figure B6: Depositor 2

Hypothetical bank balance sheets, dollars

Bank A

Bank B

Assets

Liabilities

Assets

Liabilities

Cash

65

Deposit

45

Cash

85

Deposit

75

Loan

80

Equity

100

Loan

40

Equity

50

Money creation

With two loan customers and two deposit customers undertaking transactions, the banks have
made a combined $120 in loans and have accrued $120 in deposits across the system. The
extension of loans led to the creation of deposits in the banking system and hence an
increase in money in the economy (cash plus deposits). However, the bank making each loan
did not necessarily create a deposit at their own institution as funds may be withdrawn for
use elsewhere.

More importantly, this example highlights that the creation of loans (and deposits) depends
on a number of decisions – of the borrower to approach the bank and the bank to extend
the loan. And the process is constrained by the need for the banker (and its regulator) to
ensure sufficient liquid assets to meet expected withdrawals (both drawdowns relating to the
new loan and withdrawals by existing deposit customers) and sufficient equity to absorb any
losses from loans that are not fully repaid. These constraints are also going to be
influenced by financial market conditions, including the willingness of investors to place
equity with the banks and to hold any debt that they may issue. Again, all of these various
capital and liquidity management constraints limit the ability of banks to write loans and
create deposits.

Measures of Money

As discussed above, the most commonly used types of money in modern day Australia are currency
and Australian dollar deposits at Australian financial institutions. However, the degree to
which certain types of deposits exhibit money-like characteristics varies – for example,
it may not be possible to use a term deposit that expires in a year's time to pay for a loaf
of bread you want to buy today. Hence, it is common to produce a range of different measures of
the stock of money. These are commonly called ‘monetary aggregates’. The narrower
aggregates typically include only those products that are the most money-like in terms of the
characteristics covered above. In contrast, the broader aggregates contain products that may be
less money-like on one or more of the characteristics, but which can still be thought of as
having many of the features of money.

In line with international norms, the RBA publishes key monetary aggregates each month:
currency, M1, M3, broad money and base money (Table 1).

In general terms, currency, M1, M3 and broad money represent money-like liabilities of
Australian financial intermediaries with respect to Australian households and businesses that
are not financial intermediaries. The term AFI (all financial intermediaries) is used to denote
intermediaries such as ADIs – such as banks and credit unions and building societies
(CUBS) – and registered financial corporations (RFCs) that are treated as money issuers.
Money-like liabilities of AFIs with respect to other money issuers, the government and
non-residents are generally excluded from the monetary aggregates.[16]
The measures therefore represent the money holdings of private sector Australian residents
outside the banking sector.

The money base represents the money-like liabilities of the central bank.[17]
Historically, growth in the money base has had close links to the expansion of bank balance
sheets and credit creation through fractional reserve (or similar) requirements.[18]
It has become less relevant (and received less attention) in recent decades as these
requirements have been removed. Following the period of financial deregulation in the 1980s,
these constraints have been replaced by the various requirements of the market and the
prudential regulator regarding liquidity and capital adequacy, partly decoupling banks'
balance sheets from central bank liabilities.

Table 1: Australia's Monetary Aggregates

July 2018

Measure

Description(a)

Value $ billion

Share of nominal GDP Per cent

Currency

Holdings of notes and coins by the private non-bank sector

74

4

M1

Currency + current (cheque) deposits of the private non-bank sector at banks

357

19

M3

M1 + all other deposits of the private non-ADI sector at banks (including
certificates of deposit) + all deposits of the private non-ADI sector at CUBS

Currency + banks' holdings of notes and coins + deposits of banks with the
Reserve Bank + other Reserve Bank liabilities to the private non-bank sector

109

6

(a) These descriptions abstract from some detail. See the Financial
Aggregates release for more information.

Source: ABS; APRA; RBA

We can use these measures to monitor growth in different types of money. Over the past two
decades, M3 and broad money have shared a similar trajectory, increasing as a share of GDP. The
two series are now almost indistinguishable (Graph 2). Unsurprisingly, their growth rates have
also been quite similar, averaging just below 10 per cent per annum over the past two decades
(Graph 3).[19] M1
has also increased as a share of nominal GDP over the past few decades, although it has been
broadly stable over the 2000s. Currency and the money base have been little changed as a share
of nominal GDP over the period shown.[20]
While the growth rates of the money base and M1 have been lower, they have also been more
volatile.

Graph 2

Graph 3

The sharp increase in the growth of M3 and broad money prior to and immediately following the
global financial crisis was driven initially by rapid growth in certificates of deposit issued
by banks, followed by very strong growth in term deposits and other non-cheque deposits issued
by banks. This growth in banks' deposit funding is consistent with the compositional shift
towards deposit funding discussed above.

What Can Measures of Money Tell Us about the Economy?

There are various reasons why, at least in theory, we might expect to observe a relationship
between the value of money in circulation and economic activity and/or inflation. Given money's
role as a widely accepted means of payment, the amount of financial assets held in the form of
money – as opposed to less liquid assets such as property or shares – could be
expected to have a link with expected near-term purchases. For example, we might expect that
household deposits would provide an indication of expected household consumption. Secondly,
given the link between money and credit, we would expect money growth to tend to increase when
credit growth increases, which in turn may be associated with a higher level of (nominal)
economic activity.

The potential relationships between money, economic activity and inflation have been used by
central banks in different ways throughout history. In particular, measures of the money stock
have been used to provide an indicator of economic activity. As monetary aggregates are
typically published with a shorter delay and at a higher frequency than measures of economic
activity such as GDP, they may provide early information if the aggregates have a reliable
contemporaneous relationship with activity.

In addition, there have been times when the money stock has been an intermediate target of
monetary policy. This approach to monetary policy – which was commonly used in the 1970s
and 1980s, including in Australia – differs from approaches that target an interest rate,
such as the cash rate, as an intermediate target of monetary policy.[21]
However, in the later part of the twentieth century, a wave of financial deregulation and
innovation led to the relationship between money growth and economic activity becoming
increasingly unreliable. ‘Box C: The Velocity of Money’
provides an illustration of the change in the relationship between monetary aggregates and
economic activity through the decline in the velocity of money. This change in the relationship
between money and activity prompted many central banks to move away from using monetary
aggregates as a target for monetary policy.

Box C Velocity of Money

The use of monetary aggregates as an intermediate target for monetary policy was strongly
influenced by the theory of monetarist economics. A central proposition of this theory was
the quantity theory of money, which implies that a change in the money supply leads to a
proportionate change in nominal GDP if the velocity of money – the frequency at which
a unit of money is used to purchase final goods and services included in nominal GDP –
remains constant.[22],[23] If this latter
condition were to hold, then it was considered that the monetary aggregates would exhibit a
stable relationship with inflation and output and that controlling money growth would,
therefore, result in predictable outcomes for these variables.

However, shifts in the relationship between M3 – the monetary target used by the
Reserve Bank between 1976 and 1985 – and nominal income in the early 1980s led to the
abandonment of monetary targeting in Australia.[24] One way in which the
shifts in these relationships can be seen is through examining the velocity of M3 (or other
monetary aggregates) (Graph C1). The financial deregulation of the 1980s is frequently cited
as driving the breakdown in the expected relationship between monetary aggregates and
nominal income. This more recent data shows that the velocity of money has continued to
decline following the period of rapid deregulation. As is shown in the next section, the
relationship between growth in nominal GDP and growth in monetary aggregates has continued
to vary over the past few decades.

Graph C1

It is likely that the financial deregulation of the 1970s and 1980s has influenced the
behaviour of the financial aggregates in more recent times. The well-documented rise in
credit as a share of GDP can help to explain the trajectory of broad money as a share of GDP
(the inverse of velocity) given the role of lending in deposit creation (Graph C2).[25] The
phenomenon of credit increasing as a share of GDP was common to many advanced economies over
this period.

Graph C2

How close has the relationship between money and economic activity been for Australia more
recently?

Simple graphs of annual growth in selected monetary aggregates and nominal non-farm GDP allow us
to get a general sense of the relationship between these variables over recent decades (Graph
4). The narrower M1 measure does not show much evidence of a clear relationship with non-farm
GDP throughout the period shown. In contrast, there is evidence of a relationship between broad
money and non-farm GDP over the period shown.

Graph 4

To analyse this further, we calculate contemporaneous correlations between growth in the
monetary aggregates and growth in selected activity and price variables over the period June
1978 to June 2018.[26]
Correlations between some of the narrower monetary aggregates – base money and M1 –
and nominal activity variables – non-farm GDP, private business investment and household
consumption expenditure – are weak and statistically insignificant (Table 2). In contrast,
the correlations of both currency and the broader monetary aggregates with nominal activity
variables are stronger and statistically significant. These correlations are strongest for the
broadest aggregate – broad money – and for the broadest activity measure –
nominal non-farm GDP – rather than its components. Correlations of the monetary aggregates
with prices are weaker than those with nominal non-farm GDP, but stronger than the correlations
between the monetary aggregates and real activity variables.[27]

(a) All monetary aggregates other than base money are seasonally adjusted and
adjusted for breaks to the series. Base money is neither seasonally adjusted
nor break adjusted. One asterisk indicates statistical significance at the
10 per cent level and two asterisks indicate statistical significance at the
5 per cent level. Statistically significant positive relationships are shown
in bold.

Sources: ABS; APRA; RBA

Given that financial deregulation has been linked to a breakdown in the relationship between
monetary aggregates and activity measures, we can examine whether the relationship has
re-established itself more recently. One way to do this is to estimate correlations over a
rolling window. The calculated correlations between broad money and nominal non-farm GDP over a
5- or 7-year rolling window show that the relationship has changed substantially over the past
few decades (Graph 5). During the 1980s, the calculated correlation ranged from moderately
strong to very weak and back to very strong. While this strong correlation persisted through the
early 1990s, it was replaced by a very strong negative correlation towards the end of the 1990s.
Over the past 15 years, the calculated correlations have averaged around 0.6, although with some
variation over time. This indicates that the relationship has continued to vary following the
period of financial deregulation.

Graph 5

One of the key questions addressed by Reserve Bank research on the monetary aggregates in the
1980s and 1990s was whether they contained some information about future economic activity; this
research generally found little evidence in favour of this proposition in the post-deregulation
period.[28]
While updated tests of this question are beyond the scope of this article, we can use
correlations to get some sense of the relationship. When compared to the contemporaneous
correlations, the relationship between the growth of the broader money measures in the current
period and the growth of nominal non-farm GDP one year in the future weakens. In contrast, the
relationship between current growth in M1 and future growth in various economic activity
measures strengthens; however, the correlations are relatively weak at between 0.3 and 0.5 (see
Table A1 in Appendix A). These results are broadly consistent with previous
Reserve Bank research suggesting that the monetary aggregates have limited use as an indicator
of future activity.

Conclusion

The most commonly used forms of money in Australia are currency and deposits, although other
similar products can also be considered to be money to the extent that they can be readily made
liquid for the purposes of purchasing goods, services or assets. Hence, there are various
measures of the money stock starting from the very liquid forms and ranging up to broader
aggregates that include somewhat less liquid forms of money. Money creation primarily occurs via
the extension of loans by financial intermediaries. However, their ability to do so is subject
to various limitations, including the need to ensure that lenders maintain sufficient liquidity
and capital. Correlation analysis indicates that the relationship between growth in the money
stock and various measures of economic activity has varied somewhat over recent decades. Over
the entire period since the late 1970s, there is a reasonably strong contemporaneous correlation
between growth in broad money and nominal activity; the relationship with real activity in the
current period or future economic activity is weaker.

Appendix A Additional Correlation Results

Table A1: Correlations between Monetary Aggregates and the Following Year's
Economic Activity and Inflation(a)

Correlations of annual growth rates, June 1978–June 2018

Currency

M1

M3

Broad money

Nominal Non-farm GDP

0.48**

0.29*

0.41**

0.56**

Nominal Private Business Investment

0.17

0.49**

0.06

0.16

Nominal Household Consumption Expenditure

0.62**

0.29*

0.47**

0.61**

Non-farm GDP Implicit Price Deflator (IPD)

0.62**

0.24

0.43**

0.57**

Real Non-farm GDP

0.05

0.53**

−0.09

−0.05

Real Private Business Investment

−0.07

0.43**

−0.08

−0.03

Real Household Consumption Expenditure

−0.03

0.33**

0.11

0.11

(a) All monetary aggregates are seasonally adjusted and adjusted for
breaks to the series. One asterisk indicates statistical
significance at the 10 per cent level and two asterisks indicate
statistical significance at the 5 per cent level. Statistically
significant positive relationships are shown in bold.

Sources: ABS; APRA; RBA

Footnotes

Something can be a poor store of value if it depreciates in value quickly –
ice-creams are unlikely to be a good store of value in a very hot climate without
freezers. Things that fluctuate (alternatively appreciate and depreciate) in value can
also be poor stores of value because the redeemable value may be lower than expected
when you want to undertake a transaction.
[1]

The notion of goods possessing money-like characteristics of varying degrees is
expressed by Hayek (1990; p 56): ‘… it would be more helpful for the
explanation of monetary phenomena if “money” were an adjective describing a
property which different things could possess to varying degrees’. A similar
sentiment can be found in Keynes (1973).
[2]

Exceptions include countries where multiple currencies (for example, a local currency
and a foreign currency) are in use.
[3]

On a topical side note, Richards (2018) notes that bitcoin shares very few of the
attributes of other currencies or monies.
[4]

This generalisation abstracts from the details of what is included in specific types of
monetary aggregates; the ‘Measures of Money’ section contains more
information. Lowe (2017) and Richards (2018) provide thoughts on whether there might be
a case for the RBA to issue a digital form of the Australian dollar – an ‘eAUD’
– in the future.
[5]

Prudential oversight helps to ensure that, unlike some other financial instruments,
(retail) deposits typically do not fluctuate in value based on the performance of the
ADI. Deposit insurance provides a backstop to that.
[6]

This and more information is available at the RBA Museum website: <<http://museum.rba.gov.au/>>
[7]

As banks account for the vast bulk of the ADI sector's deposit liabilities –
and total liabilities – the term ‘bank’ is generally used
interchangeably with ‘ADI’ in this text; Graph 1 and Table 1 are exceptions
to this general case.
[9]

As is described in the ‘Measures of Money’ section below, cash held by
financial intermediaries such as ADIs is typically excluded from measures of money.
[10]

A thorough exposition of this concept can be found in McLeay, Radia & Thomas (2014).
[11]

The simplest case would be one in which the buyer of the bond holds a deposit at the
same bank.
[12]

As discussed in the section on ‘Measures of Money’, bonds are not considered
to be money. The effect on the money stock will also depend on whether the buyer is a
money issuer – see ‘Measures of Money’.
[13]

The reasons for this change in funding composition have been extensively covered in
other RBA publications; for example, see Battellino (2009), Debelle (2010) and sections
4.2.1.3 and 5.5.2 of RBA (2014).
[14]

This is true for narrower measures of the money stock. As noted in the section on
‘Measures of Money’, broader measures of the Australian money stock –
such as broad money – include short-term debt securities as a type of money. For
these measures, the substitution between these two classes would have no overall effect
on the measured money stock.
[15]

Considerations such as data availability mean that there are some exceptions to this
general rule for particular liabilities and/or for particular monetary aggregates.
[16]

The money base also includes coins on issue, which are not a liability of the Reserve
Bank.
[17]

For more information see Battellino & McMillan (1989) and Grenville (1991).
[18]

As in the financial aggregates publication, the levels are not break adjusted or
seasonally adjusted, while the growth rates are.
[19]

The pronounced increase in the money base in 2013 was associated with the introduction
of open repo (where repurchase agreements are contracted without a maturity date) to
support the same day settlement of Direct Entry payments; volatility in the money base
in the mid 1990s was associated with preparations for the introduction of a real-time
gross settlement (RTGS) system in Australia.
[20]

See Edey (1997) for a discussion of various possible monetary policy systems.
[21]

This is represented by the equation MV = PY where M represents the money supply (or
stock), V represents the velocity of money and PY represents nominal GDP.
[22]

More recent versions of the quantity theory of money assert that velocity is a function
of a small number of variables that influence the demand for money, including interest
rates, income and inflation expectations (e.g. Friedman 1956).
[23]

For more background on the increase in credit to GDP in Australia, see Battellino
(2007). The RBA's submission to the Financial System Inquiry provides a more recent
perspective and details the drivers of growth in the financial sector more broadly (see
in particular Chapter 2 of RBA (2014)).
[25]

Correlations are calculated on growth rates of annual (end-June) observations, with the
activity and prices data constructed from the quarterly national accounts. The
calculated correlation coefficients are bounded between 1 (indicating perfect positive
correlation) and −1 (indicating perfect negative correlation), with 0 indicating
no correlation. A finding that the correlation is ‘statistically significant’
indicates that there can be some confidence that the underlying correlation between
those two variables is not zero.
[26]

This latter finding is not surprising given that both nominal non-farm GDP and (nominal)
broad money will tend to share a common trend relating to prices.
[27]

While research using simple correlations (such as Bullock, Morris & Stevens (1988))
found some evidence of a leading role for a narrower monetary aggregate, research
relying on more formal techniques finds little evidence of a leading relationship for
any of the monetary aggregates or that they do little to improve forecasting performance
in models with other variables (see Bullock, Stevens & Thorp (1988), Stevens and
Thorp (1989) and Tallman and Chandra (1996, 1997)). More recent analysis (Norman &
Richards 2010) found some evidence that money may be empirically relevant for future
inflation, but concluded that the relationship was not strong enough to justify
inclusion in inflation models.
[28]

Grenville S (1991), ‘The Evolution of Financial Deregulation’, in I Macfarlane (ed),
The Deregulation of Financial Intermediaries, Proceedings of a
Conference held at the HC Coombs Centre for Financial Studies, Kirribilli, pp 3–35.

Hayek FA (1990), Denationalisation of Money – the Argument Refined: An
Analysis of the Theory and Practice of Concurrent Currencies, third edition, The
Institute of Economic Affairs, London.